The bitcoin revolution

A currency in the making

In a white paper sent to a cryptography mailing list on October 31, 2008, an unidentified individual (or group) using the pseudonym Satoshi Nakamoto described what the paper’s title called “Bitcoin: A Peer-to-Peer Electronic Cash System.” This paper was soon followed by a software implementation of the cash system believed to have been compiled by Nakamoto. The software was released in open-source form January 9, 2009, on a platform called SourceForge. Since then, Nakamoto’s invention has grown to the point where the market value of Bitcoin in circulation was estimated at $235 billion on January 14, according to coinmarketcap.com. This was not even the peak for the month: Bitcoin is prone to high, even extreme, volatility (especially in December 2017).

The rise of cryptocurrency

This volatility should not detract from the fact that Bitcoin, the oldest and most established of an ever-expanding array of cryptocurrencies, has proven over the last nine years a capacity to fulfill the three main functions of money: First, it has the potential to be a reserve of value, since, its price has appreciated (significantly) since its creation, and its volatility is relatively decreasing. Secondly, it is now increasingly clear that Bitcoin could become a significant means of exchange if a solution is adopted to scale it—that is, to allow more transactions to take place and at a lesser cost. Thirdly, its global nature and increasing recognition may well lead to it becoming a fully fledged unit of account that would facilitate international payments and accounts to be processed in a single currency.

Bitcoin’s situation vis-à-vis the three functions of money has led many to suggest that it is a currency in the making. But Bitcoin and other cryptocurrencies enjoy multiple unique features that fiat currencies do not possess.

It starts by solving the very paradox that any currency issuer, be it a king from the Middle Ages or a modern central bank, has had to cope with: How do you convince users to trust your money when you are a creator of scarcity? What would prevent you from abusing people’s trust and creating more and more money, thus rendering it less and less scarce? Cryptocurrencies like Bitcoin solve this paradox by outsourcing money creation, management, and control to a computer program and a distributed decentralized network. In that way, users do not have to trust each other, or even a third party, to transact with confidence.

Cryptocurrencies, according to the serial entrepreneur and well-known cryptocurrency advocate Andreas Antonopoulos, make up an “internet of money.” They are a programmable form of money that offer endless possibilities to set and execute complex, conditional monetary transactions.

The promises of blockchain

The word “blockchain” does not appear in Nakamoto’s paper: he mentions “the chain of blocks” only once. The word only began being googled in earnest in 2012. Blockchain is the technology used by Bitcoin, namely a distributed ledger of time-stamped transactions that achieves consensus among its users through a proof-of-work (or other) algorithm. Its proponents believe it can revolutionize money, finance, and trust-based transactions in general.

Blockchain promises to extend the idea of a token representing a currency—the basis of Bitcoin—to encompass different possible uses of the token, from the most straightforward to the complex.

First, blockchain tokens can be used as money. As explained above, Bitcoin, the cryptocurrency that enjoys the highest market value and widest use, already serves as a store of value, and thus fulfills the first function of money. Its use as a means of exchange received a boost by Japanese authorities in April 2017, when they officially recognized it as a kind of “prepaid payment instrument.” It ultimately needs wider acceptance and diffusion to become a unit of account, the third function of money, but, Bitcoin’s potential to fulfill the three functions of money, and by extension the potential of any other cryptocurrency that may succeed in the future to do so as well, is palpable. Cryptocurrencies like Bitcoin are growing at such a pace that their emergence as a viable alternative to money could be measured in years, not decades.

Second, blockchains may be used as repositories of digital assets. A digital asset could be any token of a blockchain to which a special meaning is attached. A title deed issued by a land registry or a diamond certificate issued by a jeweler, for example, may be exchanged over a blockchain, which may serve as the ledger and the market for such dematerialized assets.

Third, blockchains could also become repositories and executors of smart contracts and decentralized autonomous organizations (DAO). Smart contracts and DAOs can be defined as agreements—or a series of agreements—that would be programmed to run automatically on a blockchain backbone infrastructure. The Ethereum blockchain has been built with this goal in mind, among others. Nonetheless, the utility, technical soundness, and robustness of a smart contract or a DAO remain to be demonstrated. The Ethereum blockchain—the first instance of a DAO—has been hacked on at least two different occasions, leading the Ethereum founders to suggest and implement a re-writing of their blockchain history.

The “Initial Coin Offering” hype

Between August 18, 2010, soon after the first cryptocurrencies came into being, and January 14, 2018—a span of less than seven and a half years—the compound annual growth rate of cryptocurrencies’ market value reached a staggering 637 percent. In other words, the total market value of cryptocurrencies was multiplied over the period by a factor of 2,702,050.

The attractiveness of such explosive returns is the main driver behind the hype over Initial Coin Offerings (ICOs), an appellation coined (excuse the pun) by mimicking the Initial Public Offering (or IPO) of stocks. The current rush to obtain non-binding funding through the issuance of “coins” loosely related to the blockchain technology, and squarely antithetical to cryptocurrencies, has been compared to the dotcom mania at the turn of the century. ICOs are typically launched as follows: Write a white paper stuffed with cryptographic jargon, hire a team of coders and industry veterans from the sector your coin belongs to, market your “coin” as being the next big thing among cryptocurrencies or blockchain apps, and receive bitcoins or fiat money in payment for your coins.

The overwhelming majority of these coins is centralized in a form or another. They might have a team promoting them, or a limited network of users, or an algorithm that has not been proven to be able to build and protect consensus among the network participants. The bottom line is that there is no need in the first place for these coins to use blockchain technology, since a centralized model would be much more efficient and secure for these specific uses.

There is no doubt the music will stop at a certain point, and one can safely assume that more than 99 percent of the existing cryptocurrencies (at the time of writing, there are 1,429 and counting, according to coinmarketcap.com) will fade away. ICOs, in their prehistoric form in the mid-2010s, used to be called fundraising rounds for startups, but at least in those days investors had a minimum of guaranteed rights and protections.

Large amounts of R&D, venture capital, and even ICO amounts (believe it or not, some ICO money did not go to the pockets of their promoters) have been invested into blockchain-related activities, with no breakthrough application emerging yet. Only time will tell which blockchains and cryptocurrencies will be to the ecosystem what Apple, Amazon, or eBay have been to the internet after the dotcom bubble crash.

There are mounting signs that regulators and governments are looking to reign in cryptocurrencies, possibly in a concerted effort. These efforts may well provide cryptocurrencies with credentials that accelerate their adoption. Otherwise, restrictive regulations may well open a round of confrontation between the Bitcoin ecosystem and the establishment. Nonetheless, in the case of Bitcoin, it has so far proven that the more it is attacked and downplayed, the more it thrives. This antifragile nature is intimately linked to the fact that cryptocurrencies are, in their purest form, an idea. As Victor Hugo wrote in Histoire d’un crime: “One withstands the invasion of armies; one does not withstand the invasion of ideas.”

Stéphane Abichaker is a partner at CDC Blockchain, a startup working on electronic currency solutions. He is a lecturer at Université Saint Joseph, with 15 years of experience in banking and investment banking.